Real Estate investors use various tax strategies to reduce their tax liabilities. One of the most effective solutions to reducing your tax liabilities as a real estate investor in the US is the Real Estate Professional Status (REPS). The REPS helps real estate investors treat their rental income as active income as opposed to passive income, which can be helpful in reducing significant tax liabilities.
What Are the Qualifying Criteria for REPS?
Real Estate Professional Status is a tax status recognized by the IRS. It allows real estate investors to enjoy tax-saving strategies. The REPS is imposed by Section 469 of the Internal Revenue Code. This status is aimed at real estate investors, but not everyone qualifies for the REPS. Here are the qualifying criteria for REPS:
- 50% Test – More than half of the services that you perform must be in real property trades or business in which you materially participate. This means that if you are employed in a different industry, real estate activities must make up the majority of your time.
- 750 Hours Test – You must spend more than 750 hours of service during the year in real property trades or businesses in which you materially participate. This includes tasks such as property management, repairs, maintenance, tenant interactions, and many more.
The hours spent on real estate activities and the type of services you perform must be well documented in case of an IRS audit.
What Are the Tax Benefits of REPS?
The Real Estate Professional Status can significantly impact your taxes in a positive way. Here are the tax benefits of the REPS status:
- Deduction of Passive Losses:
One of the most important tax advantages of the REPS is the ability to treat rental income as active income. This can, in turn, help to deduct passive rental losses without any limitations. Normally, taxpayers who don’t qualify for REPS are restricted from deducting rental losses if their modified adjusted gross income (AGI) exceeds $150,000. With REPS, there is no income cap on deductions, and you can use real estate losses to offset your non-passive income, such as wages, business profits, or investment earnings.
- Avoiding the 3.8% Net Investment Income Tax (NIIT):
If your rental income is considered passive income by the IRS, you may be subject to a 3.8% NIIT. REPS can reclassify your rental income as active, which helps you as a real estate investor to avoid this tax.
- Depreciation Deductions:
As a real estate professional, you can claim depreciation deductions, which lower your taxable income by accounting for the wear and tear on your property over time. This can result in substantial tax savings, particularly when applied to large-scale real estate investments.
- Tax Savings on Short-term Rentals:
Short-term rental properties (such as Airbnb listings) can sometimes qualify for REPS even though they may be subject to different tax rules than long-term rentals. If you actively manage these properties and meet the hourly requirements, you may be able to claim REPS and take advantage of its tax benefits.
Can You Spouse Benefit from REPS?
Another one of the major benefits of REPS is that if you file taxes jointly, your spouse can also benefit from the tax savings. This means that if a couple is filing jointly, either one of the spouses can qualify for the REPS status while both can benefit from the tax advantages REPS has to offer. This is particularly useful if one spouse is involved in real estate investment while the other maintains a different profession. The combined losses from real estate activities can be deducted from the couple’s joint income, significantly reducing the overall tax burden.
Is REPS Worth It?
Determining whether Real Estate Professional Status (REPS) is worth it depends on the extent of your real estate activities and your taxable income. If you actively manage multiple properties or short-term rentals, and your rental losses exceed your passive income limits, REPS can be highly advantageous. However, the time commitment and record-keeping requirements are strict. Failing to meet the IRS standards could lead to increased scrutiny and potential penalties.
Conclusion
Real Estate Professional Status is a powerful tax-saving strategy for real estate investors who actively participate in the management and development of their properties. By qualifying for REPS, you can unlock substantial tax benefits.
The tax benefits include deducting passive losses, avoiding additional taxes like the NIIT, and taking advantage of depreciation. However, the key to reaping these rewards lies in meeting the IRS’s strict requirements and maintaining accurate records to support your claim. If you and your spouse are engaged in real estate investments, REPS could significantly reduce your taxable income and help maximize your investment returns.
